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Stocks close lower as geopolitical tensions rise

We work really hard never to get confused with what we know from what we think or hope or wish. – Seth Klarman, American billionaire who founded one of the world’s largest hedge funds

Stocks closed lower for the second consecutive week despite strong earnings from the major banks as the first quarter earnings season began. Trading was relatively quiet and volume was light as many market participants were absent in anticipation of Good Friday and Easter. One couldn’t fault bank earnings for the stock market’s poor showing last week as JP Morgan Chase and Citigroup easily beat estimates on both the top and bottom lines while Wells Fargo and PNC Financial managed to post better than expected earnings. Although earnings are forecast to grow by about 10% in the first quarter, investors appeared to be cautious ahead of earnings season and distracted by geopolitical events around the world. Secretary of State Rex Tillerson visited Russia and said that U.S.-Russia relations were “at a low point”. Worries over the escalation of war in Syria and the upcoming elections in France as well as increased tension between North Korea and the U.S. only heightened investor nervousness. On Thursday, the U.S. dropped the largest ever non-nuclear bomb on an ISIS stronghold in Afghanistan. If this wasn’t enough to get investor’s attention, there was the potential for disappointment over President Trump’s pro-growth policies. Trump commented that his goal is still to implement health care reform before tackling his pro-growth initiatives. If this were true, there would be concern among investors that his agenda might be postponed indefinitely. With the stock market fully valued and much of the first quarter earnings growth already discounted in stock prices, investors can ill afford to have geopolitical tensions and domestic political uncertainty take center stage.

Last Week

Economic data on inflation last week indicated that prices remain under control as the March producer price index (PPI) fell slightly and the consumer price index (CPI) dropped 0.3%, the biggest decline in more than two years. Over the past 12 months, the core PPI (excluding food and energy) rose 2.3% while the core CPI increased 2.0%. U.S. import prices also fell modestly in March due mostly to lower oil prices. Retail sales in March declined slightly for the second straight month and were worse than expected.

On the bright side, the University of Michigan consumer sentiment index in April was better than expected and weekly jobless claims were unchanged at 234,000, marking 110 straight weeks that claims have been below 300,000, the best performance since 1970.

For the week, the Dow Jones Industrial Average fell 1% to 20,453 and the S&P 500 Index dropped 1.1% to close at 2,328. The Nasdaq Composite Index declined 1.2% to close at 5,805.

This Week

This week will feature data on the housing sector with March housing starts expected to be slightly less than the previous month and March existing home sales expected to exceed those reported in February. March industrial production, factory output and leading economic indicators are all forecast to increase modestly.

The Federal Reserve issues its Beige Book on economic conditions in its twelve districts and Boston Federal Reserve President Eric Rosengren will discuss the Fed’s balance sheet at a conference.

Earnings season begins in earnest this week with a plethora of profit reports. Among the most notable companies on the list are IBM, Qualcomm, Bank of America, Goldman Sachs, American Express, Morgan Stanley, U.S. Bancorp, Johnson & Johnson, UnitedHealth, Abbott Labs, General Electric, Honeywell, Philip Morris International, Verizon and Visa.

Portfolio Strategy

Since the S&P 500 Index bottomed in March 2009 during the financial crisis and the Great Recession, the bull market in stocks has seen prices triple over the last eight years. During this time, investors have fundamentally changed the way they invest – from active management and mutual funds to passive investing through exchange traded funds or ETFs and index funds. While index funds had been offered for decades, ETFs were first introduced in 1993 and their popularity with investors has soared due to their transparency, tax efficiency and low cost. Passive investing is when a fund simply tracks a specific benchmark such as the S&P 500 Index while active investing has holdings in a fund that are selected by an individual or team. Another distinct advantage of passive investing over active investing has been in the area of performance. Data has shown that index funds or ETFs consistently outperform active management over long periods of time. There is still more money invested in active funds than passive funds but the gap has been closing dramatically in recent years. Most actively managed funds across all equity categories failed to beat their benchmarks in 2016 as the low cost of ETFs and index funds played a major role in the difference between the two. The exception to this trend has been on the fixed income side where the majority of intermediate-term bond fund managers beat their respective benchmark last year. The best approach for investors would be to construct a portfolio with mostly ETFs using all of the major asset classes and then supplement those ETFs with a few actively managed mutual funds that have consistently outperformed their benchmark over time and have received high marks from Morningstar, a mutual fund rating service.